Corporate Finance (ANSWERED)

QUESTION

Question 4 (100 points)

Corporate finance is important to all managers because it provides the skills managers need to identify and select the corporate strategies and individual projects that add value to their firm, forecast the funding requirements of their company, and to devise strategies for acquiring those funds.

1. Why is corporate finance important to all managers?
2. Describe the ownership types a company might have as it evolves from a start- up to a major corporation. List the advantages and disadvantages of each form.
3. What are some of the less common forms of business ownership and what are the advantages of using them?

ANSWER

Introduction

Business management essentially deals with organizing, planning and analyzing activities required to run an efficient business. Business management is crucial since it helps develop essential management skills and introduces individuals to specific areas in the business world, such as finance and entrepreneurship. In addition, it assists in making strategic business decisions related to the profitability of a company and integration of finance in business. This essay analyzes the importance of corporate finance to managers and the different types of business ownership in the business life cycle.

Literature Review

The sources used were less than five years old to provide updated information on the thesis statement. Hawawini (2019) article indicates the basics of corporate finance following the renewed stakeholders versus shareholder debate. Besides, the article by Murray (2020) shows different types of partnerships. The article by Thomas (2020) shows the advantages of cooperatives and how to form a cooperative society. Zhang, Liu and Kokko (2019) and Tan (2019) expound on how business forms are integrated into the real business world. (Cooper, McClelland, Pearce, Prisinzano, Sullivan, Yagan & Zwick (2016) and Travis, 2019) also indicate the relevance of the different kinds of business in American society.

Why is corporate finance important to all managers?

Corporate finance refers to technique’s companies earn and spend funds. Corporate finance is vital to managers since it allows for precise predictions of the funds the company requires and focuses on maximizing the value of a company through its financing and investment decisions. The basic idea of corporate finance is that a company raises money from shareholders and creditors and invests in projects to get returns (Hawawini, 2019). Thus, the firm refunds money to providers through dividends and interests, and the remainder is the company value.  The financing decisions incorporate ways to fund the business, such as through shares, bonds or loans. The financing instruments have distinct characteristics in terms of costs and durations, and competent managers must align the terms with the cash flows required to generate the investments. In the investment decision, managers must weigh the risk and profitability of the projects. Corporate finance helps managers optimize the portfolio of investment projects to maximize shareholder value.

Describe the ownership types a company might have as it evolves from a startup to a major corporation. List the advantages and disadvantages of each form.

An organization may undergo various stages in the business life cycle as it grows and expands. These include sole proprietorship, partnership and corporation.

Sole proprietorship

A sole proprietorship is a type of business ownership that features an unincorporated business with just one owner. It is one of the most common types of business ownership due to its simplicity, ease of starting and low risk. There is no separate legal identity between the owner and business such that he bears all the risks and reaps all the rewards. A sole proprietor manages the company in terms of decision making, procurement and hiring of personnel. A sole trader may delegate some of his work but retains the ultimate authority over the business affairs.

Advantages and Disadvantages

A sole proprietorship is easy to form due to low startup costs and minimized paperwork. Moreover, some traders do not require specialized registration as only a license is vital in carrying out the desired business. The business is also subject to few regulations since any special regulation does not govern it. A sole proprietorship is only controlled by common law, contract law and insolvency laws in its operations. In addition, sole traders are not required to publish their financial information to public members; thus, their business operations are confidential (Tan, 2019). Another benefit is that sole proprietorships are only taxed once. The sole trader is only required to remit the personal income tax on the revenue generated by the entity, but the entity itself is exempted from paying additional taxes.

The disadvantages of a sole proprietorship include limited life where the continuity of the business enterprise is dependent on its owner. The business has one identity; thus, death, retirement, insanity, and bankruptcy may lead to cessation.  Another limitation of a sole proprietorship is its unlimited liability, where there is no separation between the business and owner. The owners’ assets and liabilities are thus tied to the operations of the sole proprietorship. Where the business assets are insufficient to meet its debts, creditors have the legal authority to recover their dues from the sole trader’s personal property. In a sole proprietorship, there is a limitation in raising capital for the business through established channels such as bank loans or equity issuance since it depends on the entrepreneur’s credit history. Capital is employed by the sole trader from his personal resources and external funding from friends and family. Where a sole proprietor’s business grows substantially, it leads to the formation of a partnership.

Partnership

A partnership is an enterprise where ownership is shared between two or more entities. The essential features of a partnership include integrating two or more owners, business operations whose aim is profits and the sharing of surplus, losses and assets by the owners. In addition, for legal and tax considerations, the partnership has deemed an extension of its owners. The founding of a partnership is subject to a simple agreement such as a handshake between partners or a written partnership agreement. The set of laws incorporated in the Uniform Partnership Act is used in the absence of written agreements. There are three major types of partnerships; general, limited liability and unlimited liability.

In general partnerships, all partners are equally liable for the enterprise profits, debts and liabilities. In some instances, percentages are assigned to each partner and documented in the partnership agreement. All partners participate in the business management, and where there is a lack of partnership agreement, they have equal rights to control the business operations. However, any obligation made by one partner, such as a contract, is legally binding on all partners (Murray, 2020). Each partner has absolute liability thus is personally responsible for all the enterprise legal obligations. In limited liability partnerships (LLP), all partners are involved in managing the business but limit their liability for each partner’s actions. This form of partnership is often formed by partners in the same professional category, such as lawyers, accountants and doctors. The partners bear absolute responsibility for the debts and liabilities of the enterprise but are exempted from responsibility arising from errors by individual partners.

In limited partnerships, there is at least one general partner who is wholly responsible for the business operations and at least one limited partner who invests in the business but is not actively involved in the business. The general partners are personally liable for the enterprise debts and are directly involved in managing the business. Limited partners are generally investors who share in the profits but whose liability does not exceed their investments. 

Advantages and Disadvantages

One advantage of a partnership is the benefit tied to teamwork. Partnerships bring together a diverse team where team members share responsibility for running the enterprise. The diversification of talents leads to improved management since each partner heads a sector, he/she has sufficient experience. There is also greater borrowing capacity since the partnership can draw on the financial resources of each partner. The partners fund the business with startup capital; thus, pulling resources from each partner leads to more capital funds and more potential for growth. A partnership is also flexible to set up and manage since partners run the business according to their terms without external interference, and the decision-making process is quick due to a lack of bureaucracy.

In partnerships, the risk of disagreements between partners is high due to varying ideas on the management of the business. The inclusion of more than one owner leads to the difference in opinion, which can threaten the agreement’s collapse. Another challenge facing partnerships is the division of profits (Zhang, Liu, & Kokko, 2019). Partners share the profits equally as per the partnership agreement; however, issues arise where one or more partner’s contribution of effort and time is below par but receives an equal share of profits leading to discord among partners. General partnerships face potentially unlimited liability where the partners are liable for business debts and other partners’ decisions. Each partner shares the financial risk of the business; thus, their personal assets can be attached to satisfy the business liabilities. As the business continues to grow, it may develop into a corporation as it diversifies its portfolio.

Corporations

A corporation is a distinct entity, separate and independent from its owners and managers. Registration of a corporation requires the filing of a charter and by-laws. Shareholders own corporations by investing money in the enterprise through buying stock shares. The percentage of stock a shareholder owns reflects the portion of the corporation he/she owns. The governance of a corporation is done through an elected board of directors who are primarily not associated with the corporation. The board of directors has the utmost authority since they hire and evaluate top executives such as the chief executive officer and oversee vital policies and decisions. There are two types of corporations; C Corporations and S Corporations. A C-corporation is taxed differently from its owners, thus encourages more risk-taking. Subchapter S-corporation provides shareholders with limited liability (Cooper, McClelland, Pearce, Prisinzano, Sullivan, Yagan, & Zwick, 2016). A Subchapter S- corporation does not pay income tax on its surplus since they are treated as distributions to shareholders. The shareholders are thus obligated to report their distributions on their personal income tax returns.

Advantages and Drawbacks

The most vital benefit of incorporation is that shareholders have limited liability thus are not responsible for corporations’ obligations. The shareholders cannot lose more money than they have invested in the corporation. It is also relatively easier to raise additional capital in corporations through a stock sale, leading to seamless expansion. In addition, corporations can also borrow funds without guarantees from shareholders. Another advantage is the easy transfer of ownership since shareholders are free to sell their stock to others.

One significant drawback is double taxation in corporations. A corporation is first taxed on its profits and again taxed on the dividends distributed to shareholders. The corporation pays the first tax while shareholders pay the tax on dividends. However, a Subchapter S- corporation is taxed as a partnership where the shareholders remit tax on the distributed earnings. Corporations are also costly to form and manage due to the high fees involved, strict regulation and government oversight levels. In addition, there are more administrative duties such as annual meetings and keeping of records such as minutes.

What are some of the less common forms of business ownership, and what are the advantages of using them?

Limited Liability Companies

A limited liability company (LLC) is a form of business ownership that combines corporations and partnerships. The owners of an LLC are referred to as members. In the corporation aspect, the LLC members are not personally liable for the company’s obligations, while the flow-through taxation to the members is an aspect of the partnership. The management of an LLC can be directed by members or the manager’s appointment to control the company’s day-to-day operations. The formation of an LLC requires members to file articles of association with the state agency where the business is located.

Advantages

The advantages of an LLC include fewer formalities, flexibility and protection. There are few

formalities involved since members need not hold regular meetings, thus record keeping. An

LLC provides flexibility in choosing the type of tax treatment to adopt. They can either assume a sole proprietorship, partnership or corporation tax regime depending on the operating agreement

(Travis, 2019).  It is also flexible in its management structure since they are no required to

appoint an external board of directors. Members are also protected from company liabilities through the LLC limited liability status. An LLC exists as a separate legal entity; thus, members are not personally liable for the business liabilities.

Cooperatives

A cooperative is a private business organization owned and controlled by people with a common interest, such as its products. A cooperative is formed wholly for the benefit of the members. A cooperative is a voluntary association of persons; thus, members are free to join or leave at their pleasure but cannot transfer shares to another person. Each member works for the collective interest of the organization and not for his/her self-interest. In a cooperative, capital is raised from members through share capital and return on capital is fixed, usually 12% per annum. There is economic equality in terms of one man, one vote since all members enjoy equal rights. In addition, a cooperative operates under a cash and carry system where granting credit is subject to the number of cash reserves. There are five different cooperatives; cooperative credit societies, consumers cooperative societies, housing cooperatives, producer cooperatives and cooperative farming societies.

Advantages

There are reduced operating costs since members render service voluntarily and also control their supplies. Cooperatives avoid wastage due to differences in demand and supply, leading to lower risk and high liquidity. Cooperatives also achieve consumer protection since the members satisfy their needs and are exempt from exploitation by traders (Thomas, 2019). Cooperatives enjoy various fiscal concessions such as tax exemptions, lower registration fees, and financial assistance from the state agencies, leading to a greater sense of stability. Cooperatives act as a cheap source of supply since overhead expenses such as marketing are non-existent.

Recommendations

The recommendations for future research include the type of business ownership that could suit different forms of economies such as capitalism, socialism and communism. The differing financial conditions in these three economies influence how businesses are set up due to tax incentives, government regulations and the nature of business. Another recommendation entails managerial ability in the three forms of business. The control of the different forms of ownership relates to how managers employ corporate finance in their operations; thus, further research is required to determine the best managerial approach.

Conclusion

The essay researches the importance of corporate finance to managers and the different forms of business ownership in the business life cycle. Corporate finance helps managers focus on maximizing the shareholder’s value by balancing cashflows between financing and investing projects. There are three primary types of business ownership; sole proprietorship, partnership and corporation. Sole proprietorship and general partnership operate under an unlimited liability status while corporations limit the shareholder’s liability. Limited liability company is the hybrid of partnership and corporations, while cooperatives emphasize moral obligation over profits.

References

Cooper, M., McClelland, J., Pearce, J., Prisinzano, R., Sullivan, J., Yagan, D., … & Zwick, E. (2016). Business in the United States: Who Owns It, and How Much Tax Do They Pay? Tax Policy and the Economy, 30(1), 91-128.https://www.google.com/search?q=Cooper…….

Hawawini, G. (2019, June 14). Why Managers – Now More Than Ever – Need to Understand Corporate Finance. INSEAD Knowledge. https://knowledge.insead.edu/economics-finance/why-managers-now-more-than-ever-need-to-understand-corporate-finance-11741

Murray, J. (2020, July 5). How a Business Partnership Works. The Balance Small Business. https://www.thebalancesmb.com/what-is-a-business-partnership-398402

Tan, Y. (2019). Competition and Profitability in the Chinese Banking Industry: New Evidence from Different Ownership Types. Journal of Industry, Competition and Trade, 1-24.https://www.researchgate.net/publication/332771756_Competition_and_Profitability_in_the_Chinese_Banking_Industry_New_Evidence_from_Different_Ownership_Types

Thomas, J. (2019, July). Cooperatives in Business: What they Are and How to Form This Kind of Organization – Toggl Blog. Toggl.com. https://toggl.com/blog/cooperatives-in-business

Travis, A. (2019). The organization of neglect: Limited liability companies and housing disinvestment. American Sociological Review, 84(1), 142-170.https://sociology.fas.harvard.edu/news/adam-travis-article-published-asr

Zhang, L., Liu, Y., & Kokko, A. (2019). Does Ownership Determine Business Model?. Sustainability, 11(11), 3136...https://www.google.com/search?q=Zhang%2C+L.%2C……..

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